Tuesday, April 15, 2008

Bad News for the Pigou Club

Refiners run near capacity every summer as families rack up miles on family vacations. That’s one reason why gas prices jump in the summer. If McCain’s excise tax cut translated into lower prices, we’d all want to drive more, which would push up the demand for gasoline. [Greg: Actually, it's quantity demanded, not demand, since this represents a movement along the demand curve, not a shift in the curve, but perhaps pointing that out is too pedantic.]

Since the refiners can’t produce much more without building new refineries, the price has to go back up. Higher prices might stimulate a little more production and we might import more gasoline from our neighbors. But the price [received by refiners] will have to increase by almost the amount of the tax cut. Otherwise, there will be shortages. Unless the plan’s aim is to boost short-term profits for petroleum refineries, the proposal makes no sense.

This argument should be familiar to ec 10 students, as it uses the basic tools of supply, demand, elasticity, and the theory of tax incidence. Burman and Toder are saying that the short-run supply curve is almost inelastic, so the welfare gain from the tax cut falls almost entirely on producers rather than consumers.

About Me

I am the Robert M. Beren Professor of Economics at Harvard University, where I teach introductory economics (ec 10). I use this blog to keep in touch with my current and former students. Teachers and students at other schools, as well as others interested in economic issues, are welcome to use this resource.